Refer to the excerpt from Harley Davidson below and please answer the two questions, and show/explain steps - thank you.
1. Using the financial statement effects template, record separately the 2018 warranty liability transactions relating to the (1) Warranties issued during the period, (2) Recalls and changes to preexisting warranty obligations, and (3) Settlements made during the period.
2. Does the level of Harley-Davidsons warranty accrual appear to be reasonable?
Product Warranty and Recall The Company currently provides a standard two-year limited war- ranty on all new motorcycles sold worldwide, except for Japan, where the Company provides a standard three-year limited warranty on all new motorcycles sold. In addition, the Company offers a one-year warranty for Parts & Accessories (P&A). The warranty coverage for the retail customer generally begins when the product is sold to a retail customer. The Company accrues for future warranty claims using an estimated cost based primarily on historical Company claim information. Additionally, the Company has from time-to-time initiated certain voluntary recall campaigns. The Company accrues for the estimated cost associated with voluntary recalls in the period that manage- ment approves and commits to the recall. Changes in the Company's warranty and recall liability were as follows (in thousands): 2018 2017 Balance, beginning of period .. Warranties issued during the period. Settlements made during the period. Recalls and changes to pre-existing warranty liabilities .. Balance, end of period. . $ 94,200 53,367 (79,300) 63,473 $131,740 $79,482 57,834 (82,554) 39,438 $94,200 2016 $74,217 60,215 (99,298) 44,348 $79,482 The liability associated with recalls was $73.3 million, $35.3 million, and $13.6 million at December 31, 2018, 2017, and 2016, respectively. At the beginning of 2018, Harley-Davidson reported a reserve of $94,200 for estimated product war- ranty and safety recall costs (all S in thousands for this discussion). During 2018, the company added $53,367 to the reserve relating to warranties on products sold in 2018. Then, the company added another $63,473 to update the estimates it made in prior periodsthe actual costs to replace and repair recalled equipment came in significantly higher than anticipated and the company needed a catch- up accrual. As a result of these two accruals, Harley-Davidson recognized an expense of $116,840 ($53,367 + $63,473) in its 2018 income statement. During 2018, the company paid out $79,300 to settle warranty claims. The settlements include cash paid to customers for refunds, wages paid to employees who repair the motorcycles, and the cost of parts used in repairs. It is important to understand that only the increase in the liability impacts the income statement- the accrual ($116,840 in 2018) is recorded as warranty expense, which reduces pre-tax income. Pay- ments made to settle warranty claims do not affect current-period income; they merely reduce the pre-existing liability GAAP requires that the warranty liability should reflect the estimated cost that the company expects to incur as a result of warranty claims. This is often a difficult estimate to make and is prone to error. Each period, the company examines the liability and updates the amount to reflect new, more accurate information, as we saw above, for Harley-Davidson. There is also the possibility that a company might intentionally underestimate its warranty liability to report higher current income, or overestimate it so as to depress current income and create an additional liability on the balance sheet (cookie jar reserve) that can be used to absorb future warranty costs and, thus, to reduce future expenses. The overestimation would shift income from the current period to one or more future periods. Warranty liabilities must, therefore, be examined closely and compared with sales levels. Any deviations from the historical relation of the warranty liability to sales, or from levels reported by competitors, should be scrutinized. Product Warranty and Recall The Company currently provides a standard two-year limited war- ranty on all new motorcycles sold worldwide, except for Japan, where the Company provides a standard three-year limited warranty on all new motorcycles sold. In addition, the Company offers a one-year warranty for Parts & Accessories (P&A). The warranty coverage for the retail customer generally begins when the product is sold to a retail customer. The Company accrues for future warranty claims using an estimated cost based primarily on historical Company claim information. Additionally, the Company has from time-to-time initiated certain voluntary recall campaigns. The Company accrues for the estimated cost associated with voluntary recalls in the period that manage- ment approves and commits to the recall. Changes in the Company's warranty and recall liability were as follows (in thousands): 2018 2017 Balance, beginning of period .. Warranties issued during the period. Settlements made during the period. Recalls and changes to pre-existing warranty liabilities .. Balance, end of period. . $ 94,200 53,367 (79,300) 63,473 $131,740 $79,482 57,834 (82,554) 39,438 $94,200 2016 $74,217 60,215 (99,298) 44,348 $79,482 The liability associated with recalls was $73.3 million, $35.3 million, and $13.6 million at December 31, 2018, 2017, and 2016, respectively. At the beginning of 2018, Harley-Davidson reported a reserve of $94,200 for estimated product war- ranty and safety recall costs (all S in thousands for this discussion). During 2018, the company added $53,367 to the reserve relating to warranties on products sold in 2018. Then, the company added another $63,473 to update the estimates it made in prior periodsthe actual costs to replace and repair recalled equipment came in significantly higher than anticipated and the company needed a catch- up accrual. As a result of these two accruals, Harley-Davidson recognized an expense of $116,840 ($53,367 + $63,473) in its 2018 income statement. During 2018, the company paid out $79,300 to settle warranty claims. The settlements include cash paid to customers for refunds, wages paid to employees who repair the motorcycles, and the cost of parts used in repairs. It is important to understand that only the increase in the liability impacts the income statement- the accrual ($116,840 in 2018) is recorded as warranty expense, which reduces pre-tax income. Pay- ments made to settle warranty claims do not affect current-period income; they merely reduce the pre-existing liability GAAP requires that the warranty liability should reflect the estimated cost that the company expects to incur as a result of warranty claims. This is often a difficult estimate to make and is prone to error. Each period, the company examines the liability and updates the amount to reflect new, more accurate information, as we saw above, for Harley-Davidson. There is also the possibility that a company might intentionally underestimate its warranty liability to report higher current income, or overestimate it so as to depress current income and create an additional liability on the balance sheet (cookie jar reserve) that can be used to absorb future warranty costs and, thus, to reduce future expenses. The overestimation would shift income from the current period to one or more future periods. Warranty liabilities must, therefore, be examined closely and compared with sales levels. Any deviations from the historical relation of the warranty liability to sales, or from levels reported by competitors, should be scrutinized
